REITs - Thai Investor Meetings Feedback; Keep OVERWEIGHT

Keep OVERWEIGHT, sector Top Call.

We recently met with fund managers in Bangkok as we marketed S-REITs. Investor sentiment was generally positive, with most positioning on a neutral to slightly overweight stance on the sector moving into 2019. The recent dovish statements by the US Fed also seem to have given added confidence that interest rates are unlikely to spike sharply, consequently benefiting REITs.

Most questions were on the office and industrial sectors, which also seemed the most favoured sub-segments. On the hospitality sector, investors are still waiting for more clarity on RevPAR growth. The retail segment is seen as a defensive play, but most believe the sector in general has outperformed market expectations.

Key discussion points from the investor meetings are summarised below:

Valuations:

Investors in general agreed that the current S-REIT valuation does not look expensive, with the sector offering average yield and yield spread of 6.2% and 4% – both the highest in the world.

Investors also believe the recent dovish statements by the US Federal Reserve (US Fed) and trade tension uncertainties are likely to lend support to S-REIT demand in 2019;

We also note that, while the US Fed has hiked interest rates 75bps since the start of the year, Singapore 10-year bond yields have inched up 20bps during the same time period. Historically, REIT yields exhibit a closer co-relation to bond yields rather than interest rate hikes (Figure 1 in the PDF report attached).

Industrial Sector:

Investor queries were mainly centred on supply outlook and weaker operational data posted by some industrial REITs during the latest quarter. We note that industrial segment supply in general peaked in 2017, except the logistics sector – it is still adjusting to the huge influx of supply that hit the market at end-2017. c.2.9m sqf or 1m sqf pa of industrial supply is expected to come on-stream over the next three years, ie only half of the industrial supply that came on-stream over the last three years;

On the industrial demand impact from recent trade tensions, we noted that tenants are taking a longer time to firm up on leases. There has also been some downsizing due to current uncertainties. Our base case view is that demand uncertainty is a short-term phenomenon and we expect the demand situation to stabilise and pick-up in 2019, in line with GDP growth. We also highlight the possibility of some high-end industrial demand from the region being shifted to Singapore if trade tensions prolong.

Demand in the electronics sector has been showing some weakness of late, with a slowdown in tech demand. Other industrial sectors, such as precision engineering, transport engineering, and biomedical manufacturing, are still seeing good positive y-o-y growth. Among the sub-segments, we are most bullish on business & science parks, as well as high-tech manufacturing demand – with the logistics segment seen as a recovery play in the latter half of 2019.

Office Sector

On the office sector, we highlighted the steady pick-up in Grade-A office rent, which has helped narrow down the rental gap between expiring and new leases signed – there has been a mix of positive and negative rent reversions seen in office REITs’ latest quarter results.

We believe the effect of positive rent reversions is likely to be seen in office REITs only from 2H19. Consequently, early 2Q19 might be an opportune time to re-enter the sector.

Aside from slowdown in supply, we also highlighted to the investors that a few office assets will be taken off the market for upgradation in 2019 – this includes Chevron House and Shaw Building. Investors also queried on CapitaLand Commercial Trust’s (CCT) HSBC Building, with the sole tenant’s – HSBC – lease expiring in 2020. CCT is currently evaluating potential options and a redevelopment of the asset seems to be the most likely option, in our view, considering the asset’s prime location.

Investors also queried on the growing trend of co-working spaces and their impact on office demand. In our observation, co-working spaces has been one of the fastest-growing sectors in terms of office demand over the last 1-2 years. A report in July by Edmund Tie & Co pointed out that there were c.110 co-working spaces in Singapore, amounting to 1.1m sqf of office space or c.2% of inventory as at May. Edmund Tie & Co also expect demand to see a stellar 42% y-o-y increase in occupied space to 1.4m sqf by end-2018.

Our take on this is that, while this segment has indeed been a boon to office sector demand, there are also potential risks from co-working operators’ aggressive expansions – this might eventually lead to lower effective rent, as they pose a head-on competition for smaller-sized tenants that generally tend to pay higher rent on a psf basis.

Hospitality Sector

Investors noted that, while the demand-supply dynamic has turned favourable, hospitality REITs have yet to see clear revenue per available room (RevPAR) growth. Based on our discussions, we sense that investors were still waiting on the sidelines to gain more clarity on the sustainability of RevPAR growth for hospitality REITs moving into 2019.

Investors also opined that most hospitality REITs are now well-diversified across other markets, which – in general – have seen a muted performance.

There were also queries on the Chinese visitor growth for the Singapore market. While visitor numbers from China are still seeing healthy growth – YTD-October y-o-y: +8.3% vs overall YTD visitor growth: +7.1% – the recent rise in Chinese arrivals seem mainly driven by an increase in visitors from the country’s tier-2 cities vis-à-vis tier-1 urban centres. In general, the former have lower spending power when compared to the latter.

Retail sector

On retail REITs, we highlighted to the investors that, despite the challenging environment, such REITs have managed to perform well – booking stable occupancies and flattish rent reversions. However, the retail sector supply still remains high at 1.5m sqf for 2019, with three big malls – Jewel Changi Airport, Funan, and Paya Lebar Quarter – expected to open.

Overseas REITs

Investors queried on our view over speculations surrounding tax reforms impacting US-based REITs. We believe the probability of any drastic change is low, as the existing structure is used by a large number of private funds and will have a broader impact on foreign investments in the US.

Additionally, we are of the view that the recent mid-term election results have made it harder for the current US Government to make drastic changes in tax regulations.

On China-based REITs, investors’ main concerns were mainly on the falling CNY and its impact on distributions, as well as the ramifications of the US-China trade War. For REITs with a major exposure towards the Australian hat growth seemed to have peaked and had been slowing down.

Our Sector Preference Is Industrial and Hospitality

Our sector preference is industrial and hospitality REITs on favourable demand-supply dynamics and attractive valuations. While office sector rent has been on a steady uptrend, the positive effects are likely to be seen in DPU in late 2019 only. As such, we believe the sub-sector will be more of a 2H19 play.

The retail segment still remains challenging, with many key shopping malls adding to supply in 2019 and rental rates likely to stay flattish. We recommend investors to buy on dips for retail and office REITs.

Stock analysis research and articles on this site are for the purpose of information sharing and do not serve as recommendation of any transactions. You will need to make your own independent judgment regarding the analysis. Source of the report is credited at the end of article whenever reference is made.